Estimates of Fundamental Equilibrium Exchange Rates, May 2010

This policy brief updates Cline and Williamson's estimates of fundamental equilibrium exchange rates (FEERs) to May 2010 using the data to March contained in the April issue of the International Monetary Fund's World Economic Outlook. The IMF's data are updated to May by subsequent exchange rate changes and Cline's estimates of the impact of exchange rate changes on trade flows. In addition, the assumptions about current account targets have been somewhat modified from previous years: All countries are now assumed to aim to keep current account balances within 3 percent of equilibrium, whereas formerly some countries with large net foreign assets to GDP ratios (NFA/GDP) were allowed larger targeted imbalances. The fundamental question explored is what pattern of exchange rates is consistent with satisfactory medium-term evolution of the world economy, interpreted as achieving those objectives while maintaining internal balance in each country.

The big disequilibrium in the pattern of exchange rates remains the undervaluation of the renminbi and the overvaluation of the dollar. The size of this disequilibrium is, however, less than previously estimated (now 15 percent on an effective basis and 24 percent bilaterally with respect to the dollar), due to the decline in the IMF's estimate of China's prospective current account surplus. The recent depreciation of the euro, while increasing the size of Euroland's prospective surplus, does not threaten to lead to an internationally unacceptable imbalance (i.e., greater than 3 percent of GDP) and therefore does not create a case for international action to reverse the rise. The yen is no longer found to be overvalued on an effective basis, although if China revalued that would create a case for a stronger yen/dollar rate. Several of the other East Asian currencies would also need to appreciate bilaterally to avoid effective undervaluation. Of the 28 other economies covered, Hong Kong, Malaysia, Singapore, Sweden, Switzerland, and Taiwan are judged to need an effective appreciation and Australia, Brazil, New Zealand, South Africa, and Turkey to need an effective depreciation.